NeoPhotonics reports revenue up 8% in Q4 to $76.9m

For full-year 2017, NeoPhotonics Corp of San Jose, CA, USA (a vertically integrated designer and manufacturer of hybrid photonic integrated optoelectronic modules and subsystems for high-speed communications networks) has reported revenue of $292.9m, down 28.8% on 2016’s $411.4m. This was driven by delays in China tenders, an inventory overhang after a strong 2016, and the sale of the firm’s Low Speed Transceiver Product assets in January 2017 (to APAT Optoelectronics Components Co Ltd of Shenzhen, China). Excluding Low Speed Transceiver Products (which contributed $63.6m, or 15% of total revenue, in 2016), revenue fell by 16%. High Speed Products (for 100G-and-beyond) comprised 83% of revenue in 2017 (up from 67% in 2016), with Networking Products & Solutions comprising the other 17%. Of total revenue, 55% came from China and 20% from the Americas.

Fiscal

Q4/2016

Q1/2017

Q2/2017

Q3/2017

Q4/2017

Revenue

$109.8m

$71.7m

$73.2m

$71.1m

$76.9m

For fourth-quarter 2017, revenue was $76.9m, down 30% on $109.8m a year ago (or down 20.7% on $97m, excluding Low Speed Transceiver Products) but rebounding by 8% from $71.1m last quarter (and above the $69-74m guidance range). Sales of High Speed Products comprised 84% of total revenue.

“Driving this growth was a combination of increasing demand from our Chinese customers [up 9% on last quarter], and stable demand in the other regions we serve,” says chairman & CEO Tim Jenks.

Of total Q4 revenue, 57% came from China (down from 65% a year ago but level with last quarter) and 21% came from the Americas (down from 23% last quarter).

China’s Huawei Technologies (including affiliate HiSilicon Technologies) was again the largest customer, accounting for 42% of revenue (still down from 53% a year ago, but rebounding further from 39% last quarter). The next four customers after Huawei represented 41% of total revenue (including US-based Ciena at 19%, up from 14% last quarter). For full-year 2017, Huawei comprised 40% of total revenue (down from 50% in 2016) and the next four contributed 39%.

“In early 2017 the industry was made aware of a substantial inventory overhang of optical and semiconductor components in the Chinese Telecom OEM supply chain and, as a result, much of the reduced demand we experienced throughout 2017 was a result of our customers working through this inventory,” says Jenks. “In the fourth quarter we saw customer inventory levels reduce to the 3-4 week target range set by our customers – down from several months of inventory in mid-2017,” he adds.

Consequently, aided also by reducing factory loading, during Q4 NeoPhotonics’ net inventory was cut by more than $15m, from $82.8m to $67m, from 123 days to 99 days of inventory on hand.

On a non-GAAP basis, full-year gross margin has fallen from 29.9% in 2016 to 22.5% in 2017. Quarterly gross margin was 21.3% in Q4, down from 29.9% a year ago but recovering from a low of 18.6% last quarter. This was aided by lower inventory write-offs but partially offset by the initial impact of annual price negotiations plus lower-than-expected output from the firm’s Japan fab, where full qualification and integration of new equipment for laser manufacturing lines has taken longer than expected: “While the main causes of this have been addressed and remediated, an approximately $3m adverse impact will carry over into Q1,” notes senior VP & chief financial officer Elizabeth Eby.

Although full-year operating expense (OpEx) rose from $96.1m in 2016 to $103.2m in 2017, quarterly OpEx has been cut from $24.7m (34.7% of revenue) in Q3 to $24.1m (31.3% of revenue) in Q4. However, excluding one-time charges (officer severance costs and a bad debt write-off of $0.5m), OpEx has been cut by $1.5m. “Our restructuring announced in Q3 [involving a staff reduction, real-estate consolidation, an inventory write-down for certain programs, and a write-down of idle assets] is complete, with savings in Q4 of $1.5m in operating expenses and $0.4m in cost of goods sold,” notes Eby.

Compared with net income of $6.3m ($0.13 per diluted share) a year ago, net loss has increased from $10.9m ($0.25 per diluted share) last quarter to $11.7m ($0.27 per diluted share, worse than the expected $0.23-0.13). However, this was driven by a one-time tax impact of $3.4m ($0.08 per share) related mainly to restructuring actions at the firm’s China subsidiary. Despite this, net loss remained 15.3% of revenue from Q3 to Q4. Full-year net loss of $39.9m ($0.92 per diluted share) in 2017 compares with net income of $23m ($0.50 per diluted share) in 2016.

Cash provided by operations was $8m. Capital expenditure (CapEx) was $6m (down from $7m last quarter, and much less than the expected $10m). Free cash flow was hence $2.5m. During the quarter, cash and cash equivalents, short-term investments and restricted cash rose from $73.7m to $93.9m.

NeoPhotonics completed the annual renewal of its credit agreement with China’s CITIC Bank for RMB250m ($40m). After the end of the quarter, the firm repaid $17m drawn on the expired CITIC Bank credit line and borrowed $17m on the new credit line. NeoPhotonics has also entered into a new seven-year loan agreement with Japan’s Mitsubishi Bank for 850m Yen ($8m). Part of this was used to repay the previous 500m Yen ($5m) long-term loan.

“Specific to China, we believe customer inventory levels have normalized for our products,” says Jenks. “More importantly, [in Q4] we began to see them pull a larger volume of our products, and thus far in Q1/2018 we have seen this trend continue… Despite typical seasonality in the first quarter, we see Q1 volumes increasing modestly over Q4 levels,” he adds. “The elimination of the inventory overhang at our customers is a meaningful first step to growth in 2018.”

“With input from both China customers and carriers, we believe this near-term increase in demand is a step up to specific customer shipment volumes and is not yet a firm indication of increasing end-market demand from either additional domestic provincial tenders or in support of initial 5G trials,” says Jenks. “The expectation from our customers is that both of these end-market growth drivers will materialize to some degree later in 2018 [with second-half 2018 being much stronger than first-half 2018].”

“Outside of these China-specific dynamics, in the fourth quarter we saw modest increases with strong traction in our mid- and long-term growth drivers,” says Jenks. “We are seeing design-win strength in our new 400G and 600G product offerings across all three of our leading components, including our ultranarrow-linewidth tunable laser, 400G and 600G micro coherent driver-modulator and coherent receiver, as well as with our CFP-DCO [digital coherent optics] and multi-cast switch modules. In the fourth quarter we began shipping coherent DCO modules to initial customers and we expect volumes will grow through 2018 from a low starting base. We see strengthening demand for our multi-cast switch platform and we have increased our shipment rate accordingly,” he adds.

“The adoption of 400G and 600G data rates in data-center interconnect (DCI) and metro networks, initially in North America and subsequently in Europe and China, will provide accelerating demand for our next-generation products. We believe we are very well positioned for this next-generation growth driver with the introduction of our 400G and 600G product suite, new 1.2T applications and the growth of contentionless networks,” says Jenks. “As China continues to build out national backbone, provincial and metro networks later in the year, advance in data-center deployments and prepare for 5G wireless, we expect continuing growth in this key market. However, in the first half of 2018, there is uncertainty around when the next tenders or deployments within China may occur,” he cautions.

In first-quarter 2018, volumes are expected to increase modestly as inventory levels return to normal. However: Q1 is typically NeoPhotonics’ seasonally lowest quarter due to annual price negotiations and the impact of Chinese New Year. “Given industry oversupply, price reductions were toward the high end of the historical range of 10-15%,” notes Eby. “As typically occurs, these price reductions began to take effect in the fourth quarter with the full impact occurring in the first quarter followed by cost reductions throughout the year to mitigate the impact on gross margin,” she adds.

As a consequence, for first-quarter 2018 (with higher volumes but lower prices) NeoPhotonics expects drops in revenue to $67-73m and in gross margin to 16-20% (impacted by the $3m lower output from the Japan fab). However, aided by the increased volumes, NeoPhotonics’ inventory should be reduced further, from 99 days to 90 days on hand, and under-absorption of overheads should be relatively low. OpEx should be cut slightly to $23-24m, helping to hold net loss per share to $0.32-0.22.

For full-year 2018, NeoPhotonics sees 100G port count in China rising by 10% or more, so increased volumes will outweigh price reductions (which are mitigated through the year), leading to China revenue being flat to slightly up. Overall (globally), the increase in port count will be offset by price reductions, leading to flat revenue on the basis of the same product mix. However, since some of NeoPhotonics’ new products are generating revenue now, total revenue should grow for full-year 2018.

“We are focused on cash, cash flow and a return to profitability,” says Eby. “Operating expense reductions are complete, we have made good progress reducing inventory, and we believe that our customer’s inventories have reached normal levels,” she adds. “As we complete amortization of under-absorption charges, we remain committed to reaching breakeven with revenues in the mid-80s [of millions of dollars] and will continue actions to further reduce our breakeven point.”

“While continuing uncertainty around the timing of provincial and 5G trial tenders within China may overshadow growth from our new products in the short term, we believe the mid- and long-term market drivers for our business are compelling,” says Jenks. “These drivers, complemented by our success in new product introductions, will help us drive top-line growth in 2018 and to second-half profitability.”

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